The 10b-5 Daily

In In re Williams Sec. Litig. – WCG Subclass, 2009 WL 388048 (10th Cir. Feb. 18, 2009), the court considered whether the plaintiffs’ expert was able to “reliably link the class’s losses to the revelation of the alleged misrepresentations.” In examining the validity of the expert’s methodology, the court also provided its views on the application of the Supreme Court’s Dura decision on loss causation.

(1) Although loss causation “is easiest to show when a corrective disclosure reveals the fraud to the public and the price subsequently drops,” a “leakage theory that posits a gradual exposure of the fraud rather than a full and immediate disclosure” is permissible under the Dura decision.

(2) To be a corrective disclosure, “the disclosure need not precisely mirror the earlier representation, but it must at least relate back to the misrepresentation and not to some other negative information about the company.”

(3) The plaintiffs must be able to demonstrate that the stock price decline was due “to the revelation of the fraud and not to another significant piece of negative information that was released” at the same time.

As to the plaintiffs’ expert, the court found that his “leakage theory” failed to adequately identify when the “materialization of the concealed risk” occurred. The expert’s alternative theory – that there was a series of corrective disclosures at the end of the class period – was inadequate because he failed to show “that it was the revelation of the fraud, and not other factors, that caused the subsequent declines in price.”

Holding: Affirmed district court’s exclusion of expert testimony and grant of summary judgment in favor of defendants.

Addition: Note that the plaintiffs did not appeal the district court’s rejection of the “constant percentage” method of calculating damages.

There is now an official circuit split over the issue of whether a ’33 Act securities class action that is not removable to federal court under the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) is nevertheless subject to the removal provisions of the Class Action Fairness Act of 2005 (“CAFA”) (see this post for more background). In Katz v. Gerardi, 2009 WL 18137 (7th Cir. Jan. 5, 2009), the court held, in contrast to the Ninth Circuit, that the ’33 Act’s general grant of state court jurisdiction is modified by CAFA, which clearly provides for the removal of certain securities class actions not otherwise covered by SLUSA.

Holding: Judgment of district court vacated and remanded for further proceedings.

The U.S. Court of Appeals for the Third Circuit has issued two interesting decisions.

(1) The Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) pre-empts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In In re Lord Abbett Mutual Funds Fee Litig., 2009 WL 117002 (3rd Cir. Jan. 20, 2009), the court considered whether Congress intended SLUSA to pre-empt the entire case or just the offending state-law claim(s). The court found that that nothing in the language or legislative history of SLUSA “mandate[s] dismissal of an action in its entirety where the action includes only some pre-empted claims.” Moreover, interpreting SLUSA in this manner would have little practical effect: “plaintiffs could simply bring two or more actions in order to avoid having all of their claims dismissed – one action with the potentially pre-empted state law claims and one or more with the remaining claims.”

(2) In Alaska Electrical Pension Fund v. Pharmacia Corp., 2009 WL 213095 (3rd Cir. Jan. 30, 2009), the court had an opportunity to apply its Merck decision on inquiry notice and the statute of limitations. The court found that “investors are not put on inquiry notice of fraud when, in the context of this case, an apparently legitimate scientific dispute arises between the FDA and a pharmaceutical company.” Instead, to find the existence of inquiry notice the court required “some reason to suspect that defendants did not genuinely believe the accuracy of their statements.”

JP Morgan Chase was willing to settle with Enron’s investors over its alleged complicity in the energy company’s financial scandal, but not with its own investors. That turned out to be a prudent decision when the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of the JP Morgan Chase investors’ securities class action last week.

In ECA v. JP Morgan Chase Co., 2009 WL 129911 (2d Cir. Jan. 21, 2009), the court found that the plaintiffs’ scienter allegations suffered “from a basic problem concerning plausibility.” The plaintiffs argued that JP Morgan “concealed its transactions with Enron in return for excessive fees.” The court held, however, that it was “implausible to have both an intent to earn excessive fees for the corporation and also an intent to defraud Plaintiffs by losing vast sums of money [through loans to Enron that JP Morgan could not recover].”

Holding: Dismissal affirmed (on both scienter and materiality grounds).

Addition: The court considered whether Chase was motivated to artificially inflate its stock price via the Enron fraud so that it could use the stock as currency for its acquisition of JP Morgan. Whether this type of motive allegation can contribute to a strong inference of scienter has been an unsettled question. The court found that “a generalized desire to achieve a lucrative acquisition proposal” is common to all companies seeking to make an acquisition and fails “to establish the requisite scienter.”

The U.S. Court of Appeals for the Ninth Circuit issued two decisions this week affirming dismissals based on a failure to adequately plead scienter (i.e., fraudulent intent). The decisions – Zucco Partners, LLC v. Digimarc Corp., 2009 WL 57081 (9th Cir. Jan. 12, 2009) and Rubke v. Capitol Bancorp LTD, 2009 WL 69278 (9th Cir. Jan. 13, 2009) – are notable because they appear to tweak the court’s approach to evaluating scienter allegations.

The panels found that the U.S. Supreme Court’s decision in Tellabs meant that they could no longer dismiss a complaint because the individual scienter allegations were insufficient. Instead, as the Zucco panel held, the court needed to “conduct a dual inquiry: first, we will determine whether any of the plaintiff’s allegations, standing alone, are sufficient to create a strong inference of scienter; second, if no individual allegations are sufficient, we will conduct a ‘holistic’ review of the same allegations to determine whether the insufficient allegations combine to create a strong inference of intentional conduct or deliberate recklessness.” The Rubke panel agreed with this two-step approach, finding that it was required to perform a “second holistic analysis to determine whether the complaint contains an inference of scienter that is greater than the sum of its parts.”

Whether this dual inquiry, which appears to afford plaintiffs a second bite at the apple, will have any practical effect is difficult to say. Both panels held that scienter was inadequately plead in the respective complaints (even when evaluated holistically), with the Zucco panel noting that “a comprehensive perspective of Zucco’s complaint cannot transform a series of inadequate allegations into a viable inference of scienter.” To put it another way, can zero plus zero plus zero ever add up to something? Stay tuned.